Building a custom home is an amazing opportunity to design a space that is tailored to your lifestyle, preferences, and long-term goals. Whether you want to build a home where you can age in place or design a house where your family can grow, a custom home can help you achieve those goals. You will have full control over every aspect of the process, from selecting the perfect lot to choosing the floor plan and finishes.
While building a custom home is more affordable than you might think, many people still require financing to make their dream come true. Financing a custom home is different from getting a traditional mortgage to purchase an existing home. It often involves different types of loans, timelines, and requirements. In this guide, we’ll break down the steps involved in financing a new custom home, including what loan options may be available to you.
At Carl Deputy & Son Builders, we construct premier custom and semi-custom homes for clients throughout Kent and Sussex Counties in Delaware and Maryland’s Eastern Shore. We work within a range of budgets and will work with you to make sure that you can build the home of your dreams without breaking the bank. Reach out to talk to a member of our design and construction team about your new home build.
Have questions about building a home or making home renovations? Sometimes talking directly to an expert is easier than reading a post. Speak with a builder at Carl Deputy & Son Builders > (302) 284-3041
Understanding the Different Types of Loans
When you buy an existing home, you will typically secure a conventional mortgage to make the purchase. At closing, the lender pays the seller in full. The homeowner then makes payments to the lender until the balance is paid.
When you build a custom home, financing works differently. Most homeowners use a construction loan, which is a short-term loan that covers the cost of building the home. Instead of getting the full amount of the loan upfront, funds are disbursed in stages (known as draws) throughout construction.
Once construction is complete, the loan will either be converted into a traditional mortgage or paid off and replaced with a new mortgage loan. This financing structure protects both you and the lender while ensuring that the builder is paid throughout the project.
Explore Your Financing Options
There are a few different ways to finance a custom home build. The right option will depend on your financial situation, credit history and score, and your long-term plans.
Construction-to-Permanent Loan
The most popular option for many custom home buyers is a construction-to-permanent loan (also referred to as a “one-time close” loan). With this type of loan, you close on the loan once at the beginning of the process. The loan will fund the construction of your home, and once the house is complete, it will automatically convert into a traditional mortgage.
This option is great for buyers who want predictability and simplicity. The process is more streamlined, and many times, the interest rate can be locked in at the start. You also only pay closing costs once, instead of twice.
Stand-Alone Construction Loan
A stand-alone construction loan only covers the building phase. Once construction is complete, you will then apply for a separate mortgage, which will be used to pay off the construction loan over time.
This option does give you the flexibility to shop for a mortgage when construction is complete, which can be beneficial if interest rates drop during the construction process. However, it involves two separate closings, with two closing costs. You also risk higher interest rates when seeking a traditional mortgage at the end of construction.
Owner-Builder Loans
If you plan to act as your own general contractor, you may opt for an owner-builder construction loan. These types of loans are harder to qualify for because they are considered higher risk.
Most banks prefer experienced, licensed builders with proven track records. If you are not a professional contractor, then you may find it difficult to secure financing through this type of loan.
Government-Backed Construction Loans
Some buyers qualify for government-insured financing options. Depending on your situation, this may include a VA construction loan for eligible veterans, a USDA construction loan in qualifying rural areas, or an FHA construction loan.
These loan programs often have lower down payments or credit requirements. However, they often have much stricter guidelines, including for the property where you build.
Save for a Larger Down Payment
Whatever type of financing you choose, you should be aware that you will probably need a larger down payment than might be required for a traditional mortgage. That is because building a house is considered a riskier bet than buying an existing house for the lender.
Most lenders require a minimum of 10 to 20% down, or more, depending on your credit score and financial profile. If you already own the land where you plan to build, the equity in that property could be used towards your down payment.
The exact amount of your down payment will depend on your credit score and debt-to-income ratio, along with the builder experience, local market conditions, and project complexity. While you may not know exactly what percentage you will be required to put down for a construction loan, you should be prepared for a pretty significant down payment.
Get Pre-Approval
When you are excited about building a new house, it can be tempting to move forward with your architectural plans before you worry about the money. However, to make sure that your plans are realistic – and on budget – it is always a good idea to get pre-approved for a loan early in the process.
A lender will evaluate your credit history, income and assets, existing debt, estimated construction budget, and builder credentials. They will then pre-approve you for a specific amount of money.
Pre-approval may seem like an unnecessary step. However, it helps you set a more realistic budget and understand what your monthly payments will likely be. It can also put some hard limits on construction costs, which can help you make smarter decisions when designing your house.
Learn about the Construction Draw Process
Unlike a traditional mortgage, where the seller gets the proceeds of the loan at once, construction loans release money in stages (“draws”). This typically happens at the following points:
- Land purchase (if you need to purchase land and do not have a separate land loan)
- Foundation
- Framing
- Plumbing and electrical
- Interior finishes
- Final completion
Before each draw is released, the lender may conduct inspections, verify work completion, and approve invoices. This helps to mitigate the risk to the lender and ensure that the work is being done.
During construction, you will typically make interest-only payments that are based on the amount of funds drawn to date, not the full loan balance. This keeps your payments lower while your home is being built.
Budget for Additional Costs
When you finance a custom home, it is important to plan for expenses that might not be included in your builder’s contract. These additional costs can include things like land preparation and clearing, utility connections, permit fees, and architectural and engineering fees.
Many lenders also recommend that you build contingency funds to cover unexpected costs and overruns. Typically, this is about a 10% cushion. This way, if something unexpected happens (like the cost of particular materials shooting up), you can cover the overruns.
Make Sure You Have a Detailed Contract
Before approving any loan for a custom home, a lender will require a construction contract. This may be either a fixed price or a detailed cost-plus contract. It should include a construction timeline, detailed building plans and specifications, and builder licensing and insurance documentation.
Choosing a reputable builder can significantly smooth the financing process. Remember: lending money is a risk for banks and other financial institutions. They want to make sure that they are making a good investment. When you work with a builder with a great reputation (such as Carl Deputy & Son Builders), there is less risk of delays, cost overruns, or lender disputes.
Is Building a Custom Home Right for You?
There are a lot of reasons why a person might choose to build a custom home in Delaware. It allows you to create exactly the house you want, right down to the smallest details. Yet financing a custom home is a much different process compared to obtaining a traditional mortgage for an existing home.
Financing a custom home requires strong financial planning, patience, and organization. You will also have to collaborate with lenders and builders to obtain the financing. More than anything, most people will need to spend a fair amount of time learning about the process and putting together the right documentation to make it happen.
Financing a custom home is more involved than getting a conventional mortgage. However, for many homeowners, the payoff is worth it. If you want a house that is tailored to your needs, taste, and lifestyle, then you can’t go wrong with a custom home built by Carl Deputy & Son Builders.
Ready to Build a Custom Home? Give Us a Call.
Financing a custom home build is undeniably more complex than obtaining a traditional mortgage. With the right preparation and guidance from experts, it is possible to secure financing so that you can build a beautiful custom home. In some cases, the total cost of building a custom home in Delaware may even be less than what you would spend buying an older existing house.
At Carl Deputy & Son Builders, we firmly believe that building a custom home is worth the extra work. We build the finest quality custom homes, all with outstanding customer service to give you peace of mind in knowing that you made the right choice. We can work with a range of budgets and can help you get financing for your new home construction. To learn more or to schedule a consultation with a member of our team for a free estimate, give us a call at 302-284-3041 or fill out our online contact form.
